As a small business owner, how do you measure up in terms of revenue, expenses, and net income?
Are you able to quickly answer these questions:
- How much did you earn in sales last week?
- What is the monthly cost of running your business?
- What is your net income (or loss) so far this year?
We don’t expect you to know these numbers off the top of your head. However, one quick glance at your company’s profit & loss (P&L) statement would have revealed these amounts right away!
(Of course, this is assuming that your accounting is accurate and up to date. If you don’t have time for that, consider the benefits of outsourced bookkeeping.)
In this post, we’ll explain the basics of a P&L statement: what it is, when you need it, and why it’s important to review.
What is a Profit & Loss (P&L) Statement?
The Profit & Loss (P&L), aka the Income Statement, shows total revenue, total expenses, and the resulting profits/losses of running a business within a specified time period.
A simple equation looks like this:
Revenue – Expenses = Profits (Losses)
We’ll show you an example below, but feel free to pull your own report to follow along.
In QuickBooks Online: On the left side bar menu, click Reports. QuickBooks includes the Profit and Loss under the Favorites heading. Adjust the report period, as needed, and click Run Report.
In QuickBooks Desktop: On the top menu bar, click Reports > Company & Financial > Profit & Loss Standard. Adjust the report period, as needed, and click Refresh.
Sections of the P&L
As you can see from the example above, there are several components that go into arriving at a company’s net income or loss.
1. Income: Sometimes referred to the company’s “top line.” This is the revenue earned from the primary business activity of the company.
2. Cost of Goods Sold: What you paid to produce your product or perform your service – including materials, parts, and labor. These are often referred to as “direct costs.”
If yours is a manufacturing business, QuickBooks will automatically determine the Cost of Goods Sold by taking the cost of beginning inventory, plus purchases, less the cost of ending inventory.
3. Gross Profit = Revenue – Cost of Goods Sold
Your Gross Profit or Gross Margin, which is the percentage of income, are key performance indicators (KPI) that you should keep a close eye on.
4. Operating Expenses: Costs incurred to operate the business, which may include advertising, office expenses, professional fees, utilities, wages, and any other “overhead” expenses. These are often referred to as “indirect costs.”
5. Net Ordinary Income = Gross Profit – Operating Expenses
This can be a useful way to gauge of the profitability of your day-to-day operations.
6. Other Income/Expenses: These are items not related to the day-to-day operations of a business and may include tax expenses or miscellaneous interest income.
7. Net Income (Loss) = Gross Profit – Total Expenses
Sometimes referred to as the company’s “bottom line.”
When do you need a P&L?
At the very least, you will need yearly information from your P&L to prepare your annual tax return. Your revenue and expenses need to be reported accurately.
If you need to borrow money, your lender will likely ask for your financial statements to be sure you’re in a position to pay back a loan.
Potential investors will also want to see financial information on your company and its profitability and sustainability.
Internally, pulling your P&L monthly (or even more frequently) is a good business practice, as we’ll explain below.
Why is it important to review the P&L?
Peter Drucker is credited with saying, “You can’t manage what you don’t measure.” Because of what the P&L measures, you will be able to make better and faster decisions with more confidence. To do this, you want to consistently look at the same KPIs from prior time periods.
The amounts on your P&L show your company’s ability to generate sales and manage expenses. In most industries, you want to target 10% or more net income.
Comparing sections of the P&L over periods of time will help you to spot trends on how well your company has performed. Are revenues growing, but expenses are growing faster? Is there a seasonal fluctuation to sales? Is there a way to reduce expenses?
The P&L is one of three main financial statements that should be regularly reviewed. The P&L, Balance Sheet,and Statement of Cash Flows are the most important tools an owner uses to make decisions regarding the course and direction of the business.
Looking at these financials together will help you build a more complete picture of your company and how everything works together. For instance, how can it be that you’re turning a profit but still have negative cash flow? (We answer that here.)
In a future post, we will provide a more extensive look at the P&L, with several analyses to run in order to help you make decisions for the health and future of your business.
In the meantime, be sure that your sales and expenses are entered timely and accurately. (Ready to outsource this? Check out our range of accounting services.) You can be confident in knowing that you have the information you need to answer some important questions about the profitability of your business.